Currently, there is no formal recommended structure, particularly regarding the client’s ethics, for determining whether an external auditor should continue the business relationship with an audit client. This statement is not meant as a criticism, but rather as the backdrop for proposing that (1) a structure is needed that will assist auditors in evaluating client ethics and (2) such a structure should be institutionalized as an integral part of the continuance decision. Auditors will never be able to guarantee that a client is ethical – even those clients with detailed codes of ethics – but auditors could benefit from a more comprehensive and established process to assess a client’s commitment to ethical behavior. This paper begins by discussing some of the psychological aspects of the audit client continuance decision. Then, reviews existing, professional guidance related to evaluating client ethics. This is followed by the authors’ baseline model and client ethics evaluation checklist designed to assist external auditors in institutionalizing the evaluation of client ethics as part of the continuance decision.
Conn, C., Campbell, L. and Raiborn, C. (2019), "External Auditors, Client Ethics, and the Continuance Decision", Baker, C.R. (Ed.) Research on Professional Responsibility and Ethics in Accounting (Research on Professional Responsibility and Ethics in Accounting, Vol. 22), Emerald Publishing Limited, pp. 133-149. https://doi.org/10.1108/S1574-076520190000022008Download as .RIS
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Codes of ethics that set expectations for the professional conduct of its members have evolved along with the development of the accountancy profession. Such codes have been established by government agencies as well as professional organizations at the state, national, and global levels. The push for an international code came in 1977 when the International Federation of Accountants appointed an ethics committee and, after several years, their work produced the Code of Ethics for Professional Accountants (Sonnerfeldt & Loft, 2018). As the ethics committee evolved into the International Ethics Standards Board for Accountants (IESBA, 2016) and with subsequent revisions of the code, there has remained a core belief shared across all jurisdictions and professional organizations that a “distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the public interest” (§100.1). One aspect of protecting the public should require that auditing firms evaluate, not only their own, but their clients’ and potential clients’ ethics.
The importance of assessing client management integrity (ethics) was highlighted years ago at the 1994 Deloitte Touche and University of Kansas symposium on auditing. This result came from a study designed to understand how auditors make client acceptance and continuation decisions (Asare, Hackenbrack, & Knechel, 1994). Theories abound regarding this decision process for auditors (see Emby & Gibbins, 1988, for an introduction) and procedures for assessing client ethics continue to be a subject of debate and academic research; yet, to date, no formal processes have been developed to assist auditors in evaluating client ethics. The authors offer a proposed decision model and client ethics evaluation checklist that can be institutionalized with an emphasis on the audit client continuation decision.
Psychology of the Continuance Decision
This paper begins by discussing some of the psychological aspects of the continuance decision. Then, reviews existing, albeit minimal, professional guidance related to evaluating client ethics. This is followed by the authors’ baseline model as well as a checklist designed to assist external auditors in institutionalizing the evaluation of client ethics as part of the continuance decision. Discussions about continuance decisions appear regularly in practitioner publications or blogs and tend to focus on how much time and resources are expended on “bad” clients. Behaviors often cited by practitioners as being indicative of “bad” are clients who:
commit illegal or questionable acts that do (or could) create liability for the Certified Public Accountant (CPA);
demonstrate a tone-at-the-top that is incompatible with that of the CPA;
request professional advice, ignore it, and complain about being billed by the CPA;
disregard CPA’s deadlines, repeatedly cause crises, and complain about bills for overtime;
fail to provide all information needed and/or provide inaccurate information;
behave in a hostile manner and attempt to intimidate the CPA and/or the staff;
criticize the CPA and/or the CPA’s staff members;
need constant hand-holding and consultation (for no justifiable reasons); and
prove to be unprofitable or less profitable than other clients.
The authors placed “tone-at-the-top” as the second item on the previous list because of the significant influence this factor has throughout the client’s firm. To be “bad,” a client may not necessarily be engaged in illegal acts. The client may simply lack a level of integrity expected by the CPA and may take actions that are serious enough for external audit management to consider discontinuing the business relationship.
Certain psychological influences can make continuance decisions particularly challenging. Audit managers might think that an existing client does not need as much vetting as a potential new client. In part, this perception may be due to a psychological concept known as the “familiarity heuristic.” This means that people
[…] favor the familiar over the strange … so on a gut level we equate familiarity with safety and well-being. Indeed, the familiarity heuristic is one of the most potent cognitive biases at work in the mind …. (Herbert, 2011, para. 4)
Experts note that this heuristic can lead to irrational and, at times, self-destructive choices.
A related psychological concept is known as “escalation of commitment.” This involves continuing with a bad decision (such as keeping an unethical client) even in the face of negative feedback about the decision. Psychology experts explain the determinants of escalation of commitment as being built on the theory of cognitive dissonance:
[T]he self-justification hypothesis states that people escalate their commitment in order to avoid the dissonance between choosing an initial investment and the realization that this was a mistake. [It] has been found that the failure to reduce commitment in response to negative feedback is positively related to (a) being personally responsible for the initial decision, (b) having previously expended resources (i.e., sunk cost, time invested), and (c) feeling personally threatened by the negative feedback (i.e., ego threat). (Wieber, Thurmer, & Gollwitzer, 2015, p. 588)
It is understandable that an audit partner or manager could have such feelings about continuing with an unethical client, particularly if they brought the client to the firm. Yet, such feelings do not make it acceptable to continue with an unethical client. Consider advice from Alexis Rothberg, Communications Manager for the Association of International Certified Professional Accountants. “Just because you’ve worked with a client for several years doesn’t mean that the relationship is ideal for both parties” (Rothberg, 2017, para. 3)
Professional Guidance for Evaluating Client Ethics
A common criterion used by clients for external audit firm selection is reputation. The authors propose that auditing firms should include that same criterion (with an emphasis on ethics) in both client selection and continuance decisions. Auditing firms may want to reconsider working for a client that does not exhibit an acceptable dedication to ethical behavior. There is only minimal authoritative guidance on how to evaluate the attributes of client ethics, integrity, and reputation, except in relation to the client engaging in illegal acts, as specified in AS2405, “Illegal Acts by Clients” from the Public Companies Oversight Board (PCAOB, 2015b).
An assessment of whether an action is legal involves reviewing the rules and regulations of a society; an assessment of whether an action is ethical requires examining an individual’s or organization’s personal or agreed-upon perspective of right and wrong. Actions may be legal but not ethical or ethical but not legal. Determining “ethical” rests on evaluating an individual’s actions in relation to personal or group values; as such, different accounting firms (because they are managed by and employ different people) may have different perceptions of ethical and unethical behavior. Without some standard guidance from the profession, every audit firm is “on their own” when evaluating client ethics. Some factors to consider are provided in Quality Control Standard 8, Section 10 (QC 10), published by the American Institute of CPAs (AICPA, 2017):
Identity and business reputation of client owners, management, and board;
Client operations and business practices;
Attitude of client’s owners, management, and board toward matters such as internal control and aggressive interpretation of accounting standards;
Inappropriate limitations in scope of work;
Indications that the client might be involved in criminal activities; and
Reasons for the proposed appointment of the firm and non-reappointment of the previous firm. (A12, p. 2946)
Interestingly, these factors are not contained in guidance for evaluating a client’s ethics but rather for the establishment of an audit firm’s own system of quality control.
The Australian Accounting Professional and Ethical Standards Board (APES, 2015) 320, Quality Control for Firms, provides specific guidance on matters that should be considered when a firm is evaluating whether to accept or continue client relationships:
The identity and business reputation of the Client’s principal owners, key management, related parties and those charged with its governance.
The nature of the Client’s operations, including its business practices.
Information concerning the attitude of the Client’s principal owners, key management and those charged with its governance towards such matters as aggressive interpretation of accounting standards and the internal control environment.
Whether the Client is aggressively concerned with maintaining the Firm’s fees as low as possible.
Indications of an inappropriate limitation in the scope of work.
Indications that the Client might be involved in money laundering or other criminal activities.
The reasons for the proposed appointment of the Firm and non-reappointment of the previous Firm.
The identity and business reputation of related parties. (section 40, p. 11)
An additional observation by APES is that knowledge held by an audit firm about a client’s ethics will generally expand within the context of an ongoing relationship with the audit client.
In the revision to the Code of Ethics for Professional Accountants, the IESBA (2016) incorporated the topic of client non-compliance or suspected non-compliance with laws and regulations (NOCLAR) and noted that such issues may have a material direct effect on the financial statements but may “be fundamental to the operating aspects of the client’s business, to its ability to continue its business, or to avoid material penalties” [ §360.5(b)]. The types of laws specifically identified by IESBA in the NOCLAR provisions are shown in Table 1 and are contrasted with items identified as illegal acts by the PCAOB in AS2405. NOCLAR issues may have wide public interest implications through possible “substantial harm to investors, creditors, employees or the general public … in financial or non-financial terms” (IESBA, 2016; §360.7).
|Types of Laws per IESBA NOCLAR Provisions||AS2405 Illegal Acts|
|Fraud, corruption, and bribery||
|Money laundering, terrorist financing, and proceeds of crime||
|Securities markets and trading||Not mentioned|
|Banking and other financial products and services||Unusually large payments in cash, purchases of bank cashiers’ checks in large amounts payable to bearer, transfers to numbered bank accounts, or similar transactions|
|Data protection||Unauthorized transactions, improperly recorded transactions, or transactions not recorded in a complete or timely manner in order to maintain accountability for assets|
|Tax and pension liabilities and payments||Failure to file tax returns or pay government duties or similar fees that are common to the entity’s industry or the nature of its business|
|Public health and safety||
Sources: IESBA Code of Ethics for Professional Accountants, https://www.ethicsboard.org/iesba-code and PCAOB AS2405, “Illegal Acts by Clients.”
Depending on client management response to a NOCLAR matter, the external auditor must determine if further action is needed. A primary consideration for the external audit firm is whether to continue to have confidence in the integrity of the audit client’s management and its board. As first noted in the IESBA’s (2016) Code of Ethics, two conditions that should cause a lack of confidence is if the auditor (1) “suspects or has evidence” of [client management’s] involvement or intended involvement in any noncompliance” and (2) knows that management is aware of the noncompliance issue and “contrary to legal or regulatory requirements [has] not reported, or authorized the reporting of, the matter to an appropriate authority within a reasonable period” (§360.23).
Evaluating the ethics of an audit client’s management should be one of the most significant factors in deciding about client acceptance or continuance. For more than 15 years, the US Securities and Exchange Commission has required CPA firms to conduct background screening of clients before entering into a public company audit engagement, and many large CPA firms have utilized proprietary software to assist them in making client continuance decisions (i.e., KRisk for KPMG; FRISK for PwC; and PACE for EY). In their 2015 report on “Audit Quality,” KPMG Canada specified that engagement partners were required to perform an annual evaluation of whether to continue with existing audit and attestation clients. One factor cited for consideration was whether there had been any “significant, adverse change in the perceived integrity of current management or principal owners” (KPMG Canada, 2015, p. 23).
For assistance in making such decisions, the authors designed a decision tree model (see Fig. 1) for evaluating risks and potential outcomes related to audit client continuance decisions.
With regard to accepting an engagement, an auditing standard issued by the PCAOB (2015c) indicates that a successor auditor should discuss with the predecessor auditor items that “might bear on the integrity of management,” but the only detail provided relates to fraud, illegal client acts, and internal control matters. Another PCAOB auditing standard (AS2810, 2015d) also mentions management integrity relative to possible intentional misstatements of financial statement information; this section, however, addresses audit tests and effectiveness of internal controls. The AICPA (2007) Private Companies Practice Section published a “Client Continuance Evaluation Tool.” Step 2 of that tool can assist in determining whether the client is a “good fit” for the CPA firm and suggests the use of rankings for 17 criteria; of those, only four relate to ethics (listed below with italics added):
The client cares about our integrity.
There are no concerns as it relates to management’s integrity (reputation of owners, management, governance, etc.).
There isn’t anything that causes us to be uncomfortable about the engagement.
In working with this client, there isn’t anything that would prevent us from complying with legal and ethical requirements.
Having “no concerns as it relates to management’s integrity” or stating that there is nothing to cause the firm to “be uncomfortable” is subjective and provides a wide door for justifying either to continue or discontinue a client. Such open-ended conditions could be integrated with the NOCLAR and AS2405 items and should be equally applicable to all client relationships. Additionally, the idea of being “uncomfortable” with an engagement allows recognition that, while an external audit firm has not seen evidence that a client has engaged in improper financial statement actions, other client actions could be viewed as indicators of an organizational culture that could engender future problems.
Dropping clients can be costly. In 1996, Coopers & Lybrand said that its “tougher screening practices” for clients cost the firm at least $22 million in revenue but the firm was adamant about having a “sterling reputation” (MacDonald, 1997). The process of client evaluation often focuses on several key areas to determine whether continuance is worthwhile: job risk/complexity, job recovery/profitability, referral source/client tie-in, additional potential services, timeliness of payment, and the firm’s satisfaction in working with the client (Koziel, 2008). Additionally, the longer an audit firm serves a particular client, the more likely that firm (and the audit partner for that client) will be biased in favor of that client. In 2018, Institutional Shareholder Services and Glass Lewis & Co. (the two largest proxy-advisory firms) recommended that GE fire KPMG as its auditor after a 109-year relationship because of “the risk that a long-tenured auditor can become too close to a client” (Gryta & Lublin, 2018, p. B3). However, these areas are not the only ones linked to the audit firm’s bottom line or reputation; some clients simply do not “match” the ethical perspective espoused by the audit firm. Within each firm, one potential aspect of an annual client evaluation should be a decision to fire a client – especially one that is causing or may cause the firm’s reputation to be diminished in the eyes of its peers, the business community, and the public.
Any audit client may experience errors in judgment or honest mistakes. But, instances of the same executive managers of an audit client being repeatedly in the headlines with negative press should give the auditors pause. Continuing with such questionable clients gives only lip service to ethics and professional integrity by turning a blind eye to objectionable client behavior. “It’s natural for people to conceal or explain away minor indiscretions or oversights, sometimes without even realizing that they’re doing it” (Bazerman, Loewenstein, & Moore, 2002, para. 15, “Escalation”). But, ignoring audit client misdeeds, when the risk of legal liability or the specter of professional indecorum is a potential outcome, should negate any benefit from continued client revenue.
In 2016, KPMG made the decision to sever its ties as auditor for the entire “Gupta Business Empire due to the political storm surrounding the family’s friendship with [South African] President Jacob Zuma” because the firm believed its “association risk” was too great to continue (Le Cordeur, 2016). The problem focused on whether the Guptas were influencing Zuma’s key governmental appointments in a way that would help ensure better business deals for Gupta entities. KPMG’s resignation in March 2016 came too late; the Guptas’ Linkway Trading (a KPMG audit client) had diverted cash that was earmarked for a dairy project “to cover the expense of a lavish [Gupta] family wedding” and KPMG was seen as having “allowed” Linkway to record the cost of that wedding as a corporate business expense (Cameron, 2017, para. 3). However, this offset was “against the misgivings of a junior auditor” (Scorpio, 2017, para. 8). KPMG South Africa’s CEO Trevor Hoole (2017, para.4) stated in a formal press release:
[W]e were too slow to recognize wider public interest related to these matters, given the existing socio-political environment in South Africa. We fully understand that our client acceptance and continuance procedures must be improved to take account of this fact.
In the fall of 2015, KPMG Switzerland became the subject of an internal probe by KPMG International to establish why [the Swiss affiliate] had not picked up on irregularities at FIFA, soccer’s world governing body (Robinson & Letzing, 2016, para. 6). The following June, KPMG broke its 16-year audit ties with FIFA after the news of massive corruption and racketeering within and surrounding the organization. Their timing was questionable because the resignation came long after the May 2015 indictments by the US Department of Justice of more than 40 individuals and companies with FIFA ties.
[A]uditors take a leading role in pushing transparency in financial reporting and encouraging good corporate governance … but set no example themselves because the partnership form does not require them to do so. (Fearnley, 2002, p. 2)
The general public (as well as audit firm employees) may look askance at pronouncements or actions of the profession’s leadership group if CPAs continue with clients viewed as scandalous or unethical. “[S]ociety in general is reacting evermore to its discontent with ethically ambivalent persona” (Pucic, 2015, p. 669). In accounting firms, as in all organizations, part of ethical leadership can be defined as “…the demonstration of normatively appropriate conduct through personal actions and interpersonal relationships …” (Brown, Treviño, & Harrison, 2005, p. 120).
More aggressive strategic policies about problematic audit clients that engage in wrongdoing could lower audit risk, decrease the expectations gap, enhance the public’s perception of accounting firm integrity, and mitigate some of the legal conundrums that beset audit firms on an after-the-fact basis. Lynn Turner, former US Security Exchange Commission chief accountant and former partner at what is now PricewaterhouseCoopers, has observed that even though audit firms have been sued time and again, “[The Big 4] have learned that time tends to heal all wounds, and they have a difficult time making changes.” (El Boghdady, 2014, para. 4). Continuing to act as auditor for client companies that likely would be viewed by the public as engaged in less-than-ethical behaviors compromises the trust the public should have in the audit profession. After all, auditors are perceived as guardians of the public interest relative to corporate fiduciary responsibility and accountability and, thereby, contribute to the sustainability of the economic process (Ardelean, 2013).
The need for evaluating the ethics of a client is highlighted in the AICPA’s QC 10 which prescribes that an audit firm should obtain
reasonable assurance that it will undertake or continue engagements only when the firm … has considered the integrity of the client and does not have information that would lead it to conclude the client lacks integrity (emphasis added). (AICPA, 2017)
It is imperative to consistently be aware of an often-quoted admonition from Associate Justice of the US Supreme Court Potter Stewart: “Ethics is knowing the difference between what you have a right to do and what is right to do.”
Proposed Model for Evaluating Client Ethics
The authors suggest that external auditors need authoritative guidance on (1) how to evaluate client ethics and (2) how to communicate auditor’s expectations for clients’ ethical conduct. As noted by Samsonova-Taddei and Siddiqui (2016), “One should already possess ethical qualities in order to act in an ethical way” (p. 195). What are the ethical qualities auditors should expect of their clients? The profession needs an agreed-upon set of norms and values for clients. This could be based on a typology of virtues similar to those identified by Libby and Thorne (2004) as “mandatory moral virtues” for auditors, including: “honesty, sincerity, truthfulness, reliability, dependability, trustworthiness, integrity, independence, objectivity, principled, healthy skepticism, and concern with the public interest” (p. 486).
Taking inspiration from this typology for auditors as well as some of the accounting profession’s codes and rules of conduct, the following values and expectations for audit clients are proposed by the authors:
Integrity – demonstrating strong moral principles by actions, decisions, and methods.
Honesty – being truthful in dealing with stakeholders.
Confidentiality – maintaining information in confidence appropriate to the situation.
Competence – assuring their employees are competent.
Transparency – creating an environment of openness and encouraging ethical behavior.
Consistency – applying the other values uniformly and fairly.
These values form the basis of a tool developed by the authors, a client ethics evaluation checklist (refer to Table 2). This tool can assist the external auditor in evaluating client ethics and should be equally applicable to all client relationships. This checklist might also be incorporated as part of the procedure required under the PCAOB’s AS2401 when the audit team discusses the potential for material misstatements in the financials due to fraud.
|Evaluate the following attributes by writing “yes” or “no” in the box to the right for each of the questions below. If you did not have an opportunity to observe, write “NA” in the box. NOTE that “notification” of someone in our firm of a situation does not require a formal written report.
|Instructions for evaluating responses: Review all items that have a “No” answer. The person completing the checklist should discuss the “No” items with their manager to determine whether the items pose significant risk regarding the ethical environment of the client.|
|Name of person who completed this checklist, position/title, and date:|
|For the person completing this checklist, with regard to the ethical environment of this client, do you have any reservations about continuing our firm’s professional relationship with them? (yes or no) _________|
|If “yes,” briefly explain and also discuss the concerns with your manager.|
|Other information: This space may be used to provide details about “no” answers to the checklist.|
In addition to asking the right questions about client ethics, it is imperative to ask the right people. In other words, audit firm employees at all levels who had client interaction, from clerical staff and staff auditors to audit managers, seniors, and other partners, should be queried. During a recent discussion with one of the authors about the continuance decision, a retired partner from a regional accounting firm observed,
One thing I think we may have missed was that sometimes we did not listen to the staff enough. If they complained about a client, we likely accused them of whining. Maybe we should have been more aggressive in directly asking the staff whether we should continue with this client.
Another aspect of seeking input from a wide variety of audit firm employees about clients’ ethics is particularly important in the continuance decision. As stated in in AICPA QC 10 (A12, p. 2946): “The extent of knowledge that a firm will have regarding the integrity of a client will generally grow within the context of an ongoing relationship with that client.” Both positive and negative client behaviors can help in assessing ethics and integrity, being careful not to disregard the negative factors simply because of affiliation longevity.
Client Integrity is Critical to Continuance
In accordance with the PCAOB’s (2015a) guidance in AS2401 Consideration of Fraud in a Financial Statement Audit, auditors are supposed to assess the risks of material misstatement due to fraud after evaluating both the audit procedures and other observations (emphasis added). The authors believe a significant observation that should be made about the client’s management is whether they are generating an ethical tone-at-the-top. Table 3 provides a random, non-statistical sample of some major companies and what would likely be viewed by outsiders as their “questionable” behaviors along with the names of their audit firms. Note that most of the audit firms continued with their clients even in the face of behaviors such as spying, bribery, corruption, fraud, and discrimination.
|Company||Questionable Behavior||Time Frame for Behavior||Currentc Auditor||Prior Auditor if Current Auditor is “Post-Behavior”|
|Boeing||Multiple FCAa violations||1994–2015||Deloitte|
|BP||Deepwater Horizon oil spill||2010||EY|
|Chiquita Brands||Financing terrorist organizations||1997–2004||PwC||EY through 2007|
|Community Health Systems||Multiple FCA violations||2000–2015||Deloitte|
|Exxon||Overreporting of oil reserves||2016||PwC|
|GlaxoSmithKline||Violations of FCPAb (bribery)||2010–2013+||PwC|
|Goldman Sachs||Malaysian state fund scandal||2016||PwC|
|Halliburton||Violations of FCPA (bribery)||1994–2009||KPMG||AA until 2002 closure|
|Hewlett-Packard||Pre-texting and spying on board members||2006||EY|
|Johnson & Johnson||Multiple FCA and FCPA violations||1982–2015||PwC|
|Merck||Vioxx scandal and defrauding Medicare||2000 and 2003||PwC||AA until 2002 closure|
|Mitsubishi Motors||Overstated fuel efficiency||2016||Deloitte|
|Nike||Sweatshops in Asia||1970–2010+||PwC|
|Novartis||Gender discrimination and FCA (kickbacks)||2011||PwC|
|Northrop Grumman Corp.||Multiple FCA violations||1998–2014||Deloitte|
|Pfizer||Multiple FCA violations||2002–2016||KPMG|
|Royal Dutch Shell||Overreporting of oil reserves||2004||EY||KPMG through 2015|
|Samsung||Bribery and corruption and exploding smart phones||∼2014 and 2016||PwC|
|Siemens||Bribery and kickbacks||mid-1990s–2007||EY||KPMG through 2008|
|Tenet Healthcare Corp.||Multiple FCA violations (bribery and kickbacks)||1994–2015||Deloitte||KPMG through 2008|
|United Airlines||Corruption and serious customer issues||2015–2018||EY|
|Volkswagen||Manipulating emissions information||2014–2016||PwC|
|Wells Fargo||Fake accounts and loan investigations||2002–2016+||KPMG|
Source: Compiled from SEC litigation releases and administrative proceedings, news articles, and https.www.goodjobsfirst.org/violation-tracker.
Notes: Some behaviors are alleged, others have been proven in court, and others have involved out-of-court settlements without admission of guilt.
aFCA refers to the US federal law named the False Claims Act; 31 U.S. Code § 3729.
bFCPA refers to the U.S. federal law named the Foreign Corrupt Practices Act; 15 U.S.C. § 78dd-1.
c“Current auditor” refers to the auditor during the time of the questionable behavior unless noted otherwise in the last column.
Activities such as those listed in the second column of Table 3 should be evaluated because of “qualitative materiality.” They may not, singularly, be monetarily significant, but could be informationally significant. In some instances bribery, discrimination, or reporting fraudulent information may not result in the financial statements being materially misstated, but such behaviors may impact investor and creditor decision making and should concern the auditors. If company management engages in multiple instances of questionable behaviors over several years, auditors should assess the level of confidence that can be placed on their integrity. The tone set by management becomes the underpinning of the entire organizational culture.
According to a National Business Ethics Survey, 70% of employees said that “pressure to meet unrealistic business objectives” was the most common cause for employees to compromise ethics; 75% of those employees “identified either their senior or middle management as the primary source of pressure” (Argenti, 2015, para. 3). Such pressure sets up an “end justifies the means” perspective. Unfortunately, the end being considered in such a perspective is in the short-run. Client audit fees are a short-run metric of success; audit firm reputation and character are long-run metrics.
Since the early 1900s, the global audit profession has focused on the importance of professional ethics. Yet, there have been numerous legal judgments against auditing firms arising from client relationships. In some cases, the failings of auditors resulted from giving in to client pressure or from the client’s own wrongdoing. An exemplary way of dealing with client wrongdoing and leading by example was described by top management of EY (2016): “Our stance has consistently been that no client is more important than professional reputation – the reputation of EY and the reputation of each of our professionals” (p. 8).
The majority of external auditors adhere to the profession’s code of ethics and accomplish their work in an ethical manner. However, in addition to maintaining an emphasis on ethical conduct for external auditors, the profession should institutionalize an evaluation of client ethics as part of both the acceptance and the continuance decision. This requires development of professional guidance for assessing the virtues (such as honesty and truthfulness) expected of a client. When clients exhibit behavior that is contrary to that set of virtues, external auditors should seriously question the efficacy and potential adversities of the business relationship. Ethical client attributes (virtues) along with the decision tool and model for evaluating client ethics presented in this paper provide a starting point for discussions about how the accounting profession can establish expectations and consistently evaluate client ethics with special consideration given to the unique aspects of continuance decisions. External auditors will never be able to guarantee that a client is ethical, but they can follow a more comprehensive and institutionalized process to assess a client’s commitment to ethical behavior. As expressed by the Chartered Institute of Management Accountants (CIMA, 2007): “A good reputation is an asset and a bad one is a liability” (p. 11). External auditors need a structured approach to evaluating client ethics so that a client’s bad reputation does not become the audit firm’s liability.
Compliance with Ethical Standards
Funding: This chapter received no outside funding.
Conflicts of Interest: The authors received no research grants or funding from any companies.
Animal or Human Subjects: No animal or human subjects were involved in this chapter.
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- Chapter 1: Making Crime Pay: Timing of External Whistleblowing
- Chapter 2: Factors that Affect CPAs’ Personal Applications of Ethical Tax Standards to Ambiguous Positions
- Chapter 3: Sustainability Reporting in Us Government and Not-for-profit Organizations: A Descriptive Study
- Chapter 4: The Need for New Psychological Contracts in the Auditing Profession
- Chapter 5: Survey Research on Earnings Quality: Evidence from Japan
- Chapter 6: External Auditors, Client Ethics, and the Continuance Decision